Spain’s Banks Need Up to $78 Billion, Report Shows

Charles Penty and Ben Sills

June 22, 2012, 10:45 AM EDT

Spain’s banks would need as much as 62 billion euros ($78 billion) in capital to withstand a worst-case economic scenario, according to two consulting firms hired by the government to conduct stress tests on the lenders.

Oliver Wyman Ltd. estimated banks would need between 51 billion euros and 62 billion euros should Spanish gross domestic product shrink by a combined 6.5 percent over three years and house prices drop 60 percent from the peak. Roland Berger Strategy Consultants said lenders would need 51.8 billion euros under those conditions. The study didn’t consider potential losses on government bonds.

Spain hired the firms last month to estimate capital shortfalls as investors questioned the health of lenders pummeled by a five-year real estate slump. Spanish bank stocks surged today, paced by the nationalized Bankia SA, after the European Central Bank was said to relax rules on the collateral lenders can use for funding and Economy Minister Luis de Guindos said there was now a “roadmap” to solve the crisis.

“We believe the stress tests factor in severe enough losses,” Morgan Stanley analysts Alvaro Serrano, Lee A. Street and Sara Minelli said in a research note today. “Although some market participants were expecting more capital needs, once endorsed by the audit, we believe the 51-62 billion euros will be enough to improve confidence.”

Funding Needs

De Guindos has said Spain will use the results of the studies to determine how much money it might need to draw from the 100 billion euros made available by Europe after it requested funding to clean up banks.

He said today in Luxembourg that Spain would send a letter on June 25 to request the aid. A memorandum of understanding on the terms of the aid will be put together in the next two to three weeks and that’s more important than the formal request, de Guindos told reporters.

Not all analysts were satisfied by the results of the stress tests.

“We would have been more comfortable if these numbers had come out closer to 80 billion,” said Simon Maughan, a financial industry strategist at Olivetree Securities in London. Fitch Ratings said in a report today that the 6 percent core tier one capital ratio being used for the stress test “appears low.”

Shares Rise

Bankia surged as much as 25 percent, CaixaBank SA rose as much as 6.8 percent and Banco Popular Espanol SA climbed as much as 11.9 percent in Madrid trading. Banco Sabadell SA jumped as much as 9.3 percent after its Chairman Josep Oliu ruled out seeking state aid.

The ECB decided yesterday to lower the minimum rating threshold for mortgage-backed securities to BBB- from A-, according to an official who declined to be identified. Spanish banks have been unable to use some securities as collateral because the rating is too low, the person said.

The European Commission, which will impose conditions on how Spain’s banking industry is restructured, likes the idea of setting up a so-called bad bank to hold soured assets, Deputy Economy Minister Fernando Jimenez Latorre said at a briefing in Madrid yesterday.

“They like the idea of the bad bank, but we’ve only just started talking and it will become clearer,” Latorre said.

Spanish officials have repeatedly ruled out setting up a bad bank, which removes troubled assets from bank balance sheets by acquiring them at a discount. Latorre said the government will make its request for European bailout funds in coming days.

Adverse Scenario

The studies by Roland Berger and Oliver Wyman are based on data for banks at the end of 2011 and follow the publication on June 8 of an International Monetary Fund report that showed banks needed at least 37 billion euros to withstand a worsening economy. An IMF official said at the time Spain may need to build a buffer of 60 billion euros to 80 billion euros.

“The market is as likely to have as many questions now about the Spanish bank recapitalization as it did before the announcement,” Daragh Quinn, an analyst at Nomura International in Madrid, said in a phone interview.

In the so-called central scenario, the banks would need between 16 billion euros and 25 billion euros through 2014, Oliver Wyman said. Roland Berger said banks would need 25.6 billion euros in that situation.

The adverse scenario assumes that land values fall as much as 90 percent from their peak, unemployment reaches 25.1 percent this year, 26.8 percent next year and 27.2 percent in 2014 and 10-year bond yields stay above 7.4 percent for three years. The national unemployment rate currently stands at 24.3 percent and Spanish 10-year bonds yield about 6.7 percent.

Bailed Out

Oliver Wyman said its study estimated losses for banks of as much as 274 billion euros, an amount that would be mitigated by provisions, asset protection programs, profit generation and excess capital buffers to give the maximum 62 billion-euro capital shortfall.

Most of the capital needs are concentrated among lenders that have already been bailed out by Spain’s bank restructuring fund, Fernando Restoy, the Bank of Spain’s deputy governor, said at the Madrid briefing. The country’s top three banks won’t require a recapitalization even in the worst case, Roland Berger said, without identifying the institutions.

‘We’re not talking about someone urgently needing a certain amount of capital to meet its commitments at the moment,” said Restoy. “We’re talking about the capital that would be needed if we saw a scenario of extreme tension that is very far from being likely to happen.”

More Audits

Spain has also hired four accounting firms to review how banks account for doubtful loans. Results of the second round of the auditing process are due July 31. A third analysis, which wasn’t previously announced and will also use a “bottom-up” approach, will be published in September, Latorre added.

By mid-October, banks will have to prepare recapitalization plans for submission to the Bank of Spain and the European Commission in liaison with the ECB, the Economy Ministry and Bank of Spain said in a statement. Once approved, banks will have to raise the required capital within nine months.

The results follow previous attempts by the government this year to bolster confidence in banks by forcing them to increase provisions for soured real estate and boost reserves to cover property loans that are still being repaid.

Government orders in February and May require banks to set aside 82 billion euros for real estate, boosting provisions on those assets to 45 percent of the 307 billion-euro total.

The stress-test results don’t take into account those provisions because they are based data from the end of 2011.

‘Additional Burden’

“The results confirm that the actions carried out by the government so far were necessary and that the estimates in relation to provisions and recapitalizations were correct,” Prime Minister Mariano Rajoy said. “I repeat my wish that the financial assistance is approved as soon as possible.”

The government’s takeover of the Bankia group last month fueled investors’ concerns that repeated attempts to clean up the financial system over the past three years had failed.

Bankia, Spain’s third-biggest lender, based a May 25 request for 19 billion euros of state aid on the assumption that it would need the funds to cleanse mortgages and company loans as well as real estate.

Pedro Pablo Villasante, the general secretary of the Spanish banking association, told reporters in Madrid yesterday that he couldn’t say whether the results of the independent studies of the banking industry would result in further orders to banks to increase loan-loss provisions.

“The best way to resolve the problems is to focus on those that have problems and not place an additional burden on those that don’t,” he said. “The righteous should not have to pay for what the sinners have done.”

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